Monetary policymakers have been scrambling in the past week to push back against the dramatic shift in market expectations for rate cuts next year. This is true for Fed officials—despite the clear dovish pivot in the December meeting—and particularly so for the ECB, where Ms. Lagarde and her colleagues have been hard at work to disabuse investors of the notion that the central bank will start cutting rates in the first half of next year. Are central banks right to lean into the prevailing market winds here? It’s all in the eye of the beholder. The chart below plots futures-implied policy rates for the Fed and ECB through 2027. The focus at the moment is on 2024, where markets see 150bp and 120bp worth of cuts from the Fed and ECB, respectively. That sounds like a lot, but then again, inflation is now falling rapidly. The question we need to ask is whether markets will be fed information over the next few months that will drive a shift in pricing. I am not sure, and if they aren’t, talk from policymakers will be cheap.
Read MoreAccording to U.S. Treasury Secretary Janet Yellen economists who predicted that a sustained period of high U.S. unemployment—and perhaps even recession—would be needed to bring down inflation are now “eating their words”. This follows earlier comments by Ms. Yellen last month that a soft landing is “on track.” Claudia Sahm, a US macroeconomist, agrees. In an interview with the FT earlier this month, she says:
The soft landing is not here yet. But it is in the bag.
Markets seem to agree with the assessment by the Treasury Secretary and Ms Sahm; bonds have rallied like a bat of hell in the past month—temporarily pegged back by a semi-hot NFP report on Friday—and equities are in a good mood too. November, I am reliably told by the financial media, was the best month for a standard 60/40 portfolio … ever. And why wouldn’t markets be celebrating? Inflation in the developed world is now falling rapidly, and what was a significant inflation shock in core prices has now been turned on its head, as the charts below show.
Read MoreEveryone is talking about the sell-off in bonds these days. Yields on the US 10-year benchmark is up nearly 150bp since April, within touching distance of 5%, and 30-year yields are now just over 5%, up from 3.7% in April. With the two-year yield up just 100bp over the same period, the curve has bear steepened by 50bp, and is now looking to un-invert due principally to a sell-off in long bonds, contrary to widespread expectations of bull-steepening via a rally in the front end. The 2s10s is still inverted by around 17p , but the 2s30s is now—as far as I can see from the close on Friday the 20th of October—just about positive. No wonder that the long bond is on everyone’s mind. Sustained bear-steepening during inversions are rare sights in G7 bond markets, so when they are spotted in the wild, they tend to grab the attention and imagination of investors and analysts. But what does it mean? Put on the spot, I’d say that bond market volatility is underpriced.
Read MoreI have a few speaking engagements coming up, prompting me to update my view on the world beyond the borders of the Eurozone, which makes up the day job. One trend that I am looking forward to present to, and discuss with, investors and capital allocators is the tension between signs that the inflation and interest rate shocks are now fading, in a cyclical sense, and the risk that inflation will stabilise above 2%, posing a challenge for monetary policymakers. Will they channel their inner Volcker or fudge the 2% inflation target?
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